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'Time To Move From Liquid Funds To Short, Medium-Term Bonds'

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As the interest rate cycle appears to have peaked, N Sethuram Iyer, chief investment officer, Daiwa Asset Management, feels this would be the right time for investors to move into short and medium term bond funds. Talking to Businessworld, he said 2012 appeared to be a year for investing in fixed income rather than equity, as one could look at returns of around 10 per cent or higher in fixed income funds over the next one year. Confident that this is a time for a gradual shift to longer maturities in debt funds and increasing the mark-to-market component in portfolios, Iyer also feels the uncertainty in equity market will continue and a defensive portfolio in FMCG, pharmaceutical, telecom and IT will be the preferred bets at this point of time.
Excerpts from the interview

What has been your analysis of the Reserve Bank of India's (RBI) monetary policy? And why?
RBI Policy review was on expected lines with no rate action in any of the reference rates.  RBI has also indicated that future monetary policy responses will take into account the risks to growth. The emphasis has therefore shifted from inflation targeting to managing downward pressures on growth. The clear indication is that there would be no further rate hikes.

On the liquidity side, RBI has clearly indicated that open market operations (OMO) would be the route taken to manage the liquidity position.

Globally countries are cutting rates. How do you see the interest rate cycle panning out in India and why? Will RBI wait to cut rates till inflation falls below 6 per cent?
There is a clear indication that interest rate easing would depend on the economic growth numbers that will emerge in the future. RBI has indicated that while inflation would moderate, it may remain above the comfort zone for some time. We believe that RBI could consider rate cuts even before inflation gets into the comfort zone of below 6 per cent. We feel that if the growth numbers continue to remain weak, action could be taken in cutting rates within a few months if the inflation continues to have a downward trajectory.

Despite increasing the FII window in G-Sec and corporate bonds, why aren't we seeing inflows coming into these market? Surprisingly, on a risk adjusted basis, they can make a risk free return of 3-3.5 per cent.
The restrictions relating to minimum period lock-in in respect of G-Sec and corporate bonds are being relaxed and we will be seeing very active interest from FIIs to participate in the Indian debt market papers.

Going forward, where do you see the 10-year government securities and why? Will 10-year cross 9 per cent? Are you buying G-Sec? Which maturities are you favouring and why?
Yields on 10-year government securities had very likely peaked at around 8.85 per cent levels witnessed a few weeks back. We believe that the yields would gradually come down in tandem with the RBI action relating to short-term interest rates. The yield curve which indicates inversion in the short-term securities would likely realign over the short term and we would gradually witness a parallel downward shift in the yield curve. This is clearly a time to go for longer maturities where the returns would be significantly higher over the next 6–9 months.

What is your take on the 1-year, 2-year, 3-year, 5-year and 10-year yields in corporate bonds? Will you be a buyer in corporate bonds and what would be the tenure?
In respect of corporate bonds, we expect a significant downward drift in yields at the shorter end, which would be more liquidity driven, while we do not see major shift in the yield pattern in long maturity bonds.

It's been seen that the market is favouring Certificate of Deposits rather than corporate bond. Why is that?
Certificate of Deposits have better liquidity and that would be the primary reason for CDs being preferred to corporate bonds. Also, so far the preference has been in the very short maturity papers where yields have been high due to liquidity in the system remaining tight.

Why is commercial paper languishing in the market?
Commercial papers are less liquid as compared with CDs. Besides, with the slowing of the economy and the rising incidence of NPAs in the banking sector, credit risks in companies issuing CPs would be scrutinized in greater detail.

In times of uncertainty, where will you advice investors to invest? Currently where are you investing your money? And why?
As the interest rate cycle appears to have peaked, this is a good opportunity for investors to gradually move into short and medium term bond funds, which can benefit for slightly longer maturity securities as and when the interest rate cycle is reversed. It would make sense to gradually shift from Liquid Funds to Short term and medium term bond funds over the next two to three months.

Is the fund house seeing an inflow of money? How much of it is coming into fixed income and how much into equities and in which schemes? 
2012 clearly looks to be a year for investing in fixed income as compared to equity. One can look at returns of around 10 per cent or higher in fixed income funds over the next one year.

As a fund manager how are you managing the money in your portfolio and where are you investing in this market (both equity and debt)?
This is clearly a time for a gradual shift to longer maturities in Debt Funds and increasing the mark-to-market component in portfolios. The equity market continues to look uncertain and a defensive portfolio (FMCG, pharma, IT, telecom) are the preferred bets at this point of time.

Where do you see the equity markets in the short and medium term and why? Is it a good time to buy equities?
Equity markets are likely to remain range bound in the short and medium term with a slightly negative sentiment. Third quarter earnings are likely to be under pressure on account of input costs going up and also on account of currency weakening and other factors. One needs to wait for clear indications both on the reform front and definitive actions from RBI in respect of interest rates before getting comfortable that growth can rebound. We would advise investors to have caution in equity investments in the very short term.


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